CHI-1912664v7 UNITED STATES DISTRICT COURT EASTERN DISTRICT OF MICHIGAN SOUTHERN DIVISION In re CITY OF DETROIT, MICHIGAN, Debtor, : : : : : : : : : Chapter 9 Case No. 13-53846 Hon. Steven W. Rhodes OMNIBUS REPLY OF THE DEBTOR TO OBJECTIONS TO DEBTOR’S MOTION FOR APPROVAL OF POSTPETITION FINANCING 13-53846-swr Doc 2023 Filed 12/10/13 Entered 12/10/13 16:43:32 Page 1 of 53
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CHI-1912664v7
UNITED STATES DISTRICT COURT EASTERN DISTRICT OF MICHIGAN
SOUTHERN DIVISION
In re CITY OF DETROIT, MICHIGAN,
Debtor,
: : : : : : : : :
Chapter 9
Case No. 13-53846
Hon. Steven W. Rhodes
OMNIBUS REPLY OF THE DEBTOR TO OBJECTIONS TO DEBTOR’S MOTION FOR APPROVAL OF POSTPETITION FINANCING
A. The Broad Review Advanced By The Objectors Is Not Justified ....... 7
1. The Quality Of Life Initiatives Are An Exercise Of The City’s Political Judgment About How Best To Fulfill Its Governmental Obligations ......................................................... 8
2. Section 904 Prohibits Efforts By Creditors To Second-Guess the City’s Political Judgments ......................................... 9
3. The City’s Effort To Obtain Approval Of Liens And Superpriority Claims Under Section 364(c) Is Not Consent To The Broad Review Advanced By The Objectors .................................................................................. 11
B. Appropriate Standard of Review For the Relief Sought in the Motion ................................................................................................ 13
1. Applicability of the Farmland Factors .................................... 13
2. The Financing Should be Approved Even Under Farmland Factors ..................................................................... 16
a. The Financing is a Sound Exercise of the City’s Judgment ........................................................................ 16
b. The Financing Satisfies Any Appropriate “Best Interests” Analysis ......................................................... 21
c. The Terms of Financing are Fair and Reasonable and There Were No Better Alternative Financing Options Available .......................................................... 28
d. A Section 364(e) Finding is Appropriate ...................... 32
C. Key Investments in the City Must Begin Now .................................. 37
1. The City is Not Required to Wait Until Plan Confirmation to Begin Critical Investments ............................ 37
2. The Financing is Not a Sub Rosa Plan ..................................... 39
D. The Super-Priority Claim Objections Are Specious .......................... 41
In re 495 Cent. Park Ave. Corp., 136 B.R. 626 (Bankr. S.D.N.Y. 1992) ................................................................ 22
In re Addison Cmty. Hosp. Auth., 175 B.R. 646 (Bankr. E.D. Mich. 1994) ............................................. 9, 10, 27, 38
In re Ames Dep’t Stores, Inc., 115 B.R. 34 (Bankr. S.D.N.Y. 1990) .................................................................. 15
In re Babcock & Wilcox Co., 250 F.3d 955 (5th Cir. 2001) .............................................................................. 22
In re Barnwell Cnty. Hosp., 471 B.R. 849 (Bankr. D.S.C. 2012) .................................................................... 26
In re Braniff Airways, Inc., 25 B.R. 216 (Bankr. N.D. Tex. 1982) ................................................................. 38
In re Braniff Airways Inc., 700 F.2d 935 (5th Cir. 1983) .............................................................................. 40
In re City of Columbia Falls, Mont., Special Imp. Dists., 143 B.R. 750 (Bankr. D. Mont. 1992) ................................................................ 26
In re City of Stockton, 478 B.R. 8 (Bankr. E.D. Cal. 2012) .................................................................... 10
In re City of Stockton, 486 B.R. 194 (Bankr. E.D. Cal. 2013) .......................................................... 10, 11
In re Connector 2000 Ass’n, Inc., 447 B.R. 752 (Bankr. D.S.C. 2011) .................................................................... 26
— Section 904 of the Bankruptcy Code does not prevent an exhaustive review by the Court of the intended uses of the Quality of Life Financing because the City has sought approval from this Court of the Postpetition Financing.
— The proper standard of review for the relief sought by the City in the Motion is set forth in the Farmland factors. This issue encompasses the following assertions:
○ The City has failed to sufficiently disclose the need for financing, how the Quality of Life Financing will be spent and on what timeframe, thus establishing the City’s business judgment.
○ The City has failed to establish that the Postpetition Financing is necessary to provide only essential services to citizens and that the Postpetition Financing will enhance recoveries to creditors.
○ There is insufficient factual basis to make a finding of “good faith” pursuant to section 364(e) of the Bankruptcy Code.
— The Postpetition Financing constitutes an impermissible sub rosa plan of adjustment.
— Reinvestment initiatives of the kind contemplated in the Motion should be done as part of a comprehensive plan of adjustment and not on a “piece-meal basis.”
— The Postpetition Financing imposes unreasonably high costs on the City.
— Super-priority claims granted pursuant to the Motion, if at all, should not “apply” to certain ad valorem tax revenue of the City in which certain bondholders (and bond insurers) allege they have an interest.
17. As set forth in greater detail below, the Objections are legally
deficient and cannot be sustained.
REPLY
A. The Broad Review Advanced By The Objectors Is Not Justified
objecting parties disregards this history and attempts to revive the “necessary for
essential government purposes” test long ago rejected by Congress. See, e.g.,
Ambac Objection at 18-19 (“[T]he City has the burden . . . to show that the funding
sought is to maintain essential services.”); Id. at 21 (“[T]he Court will be required
to determine whether the Post-Petition Financing is necessary to maintain essential
services for the citizens of Detroit during the case . . . .”).
3. The City’s Effort To Obtain Approval Of Liens And Superpriority Claims Under Section 364(c) Is Not Consent To The Broad Review Advanced By The Objectors
24. Recognizing that the plain terms of section 904 prohibit the
type of review they seek, certain of the objecting parties argue instead that the
City’s effort to obtain approval of its Motion should be interpreted as a waiver of
section 904 and consent to a broad review of its Quality of Life expenditures.
Such a conclusion is unjustified. It is true that a municipality provides limited
consent to bankruptcy court involvement with its governmental decisions when it
seeks to use the tools of the Bankruptcy Code to accomplish something it could not
do without court involvement. See Stockton, 486 B.R. at 199. That consent,
however, extends only so far as necessary to accomplish the proposed transaction.
See id.; Leco Properties v. R.E. Crummer & Co., 128 F.2d 110, 113 (5th Cir. 1942)
(“[W]hile the jurisdiction conferred by the statute depending, as it does, upon the
city’s volition, [it] may not be extended by the court beyond that volition . . . .”);
(confining the court’s review to the issues to which the municipal debtor had
consented).
25. In this case, the City neither needs nor seeks court approval for
its governmental decision to spend money on the Quality of Life initiatives. See
11 U.S.C. § 904. Moreover, because section 364(b) does not apply to a chapter 9
case,4 the City also does not need or seek this Court’s authorization to borrow
funds to pay for these initiatives. See 11 U.S.C. § 901. Rather, the City seeks this
Court’s authorization only for its decision to grant liens on certain revenue streams
and superpriority claim status to Barclays and this Court’s finding of good faith. It
is for this limited aspect of the transaction that the City’s financial transaction is
subject to Court review.
4 Indeed, as noted in the legislative history to chapter 9, “if a
municipality could borrow money outside of the bankruptcy court, then it should have the same authority in bankruptcy court, under the doctrine of Ashton v. Cameron Water District No. 1, 298 U.S. 513, 56 S. Ct. 892, 80 L. Ed. 1309 (1936) and National League of Cities v. Usery, 426 U.S. 833, 96 S. Ct. 2465, 49 L. Ed. 2d 245 (1976). Only when the municipality needs special authority, such as subordination of existing liens, or special priority for the borrowed funds, will the court become involved in the authorization.” See H.R. Rep. No. 595, 95th Cong. 1st Sess. 394 (1977).
objecting parties have also argued that the relief sought in the Motion should be
judged using the factors set forth in the chapter 11 case of In re Farmland Indus.,
Inc., which consist of the following:
— That the proposed financing is an exercise of sound business judgment;
— That no alternative financing is available on any other basis;
— That the financing is in the best interests of the estate and its creditors;
— Whether there are any better offers, bids, or timely proposals before the court;
— That the financing is necessary to preserve assets of the estate;
— That the terms of the financing are fair, reasonable, and adequate given the circumstances; and
— The financing was negotiated in good faith and at arm’s length.
294 B.R. 855, 879-880 (Bankr. W.D. Mo. 2003).
29. Nevertheless, it is hardly clear that these factors apply in a
chapter 9 case, as asserted by many of the objecting parties. While certain courts
certainly have cited Farmland favorably in chapter 11, the City is not aware of a
single case applying these or similar factors in a chapter 9 proceeding.5 Moreover,
5 While post-petition borrowings may be rare in chapter 9, contrary to
common belief (and at least one of the Objections) a sizable post-petition borrowing has occurred before in chapter 9 in the case of In re County of Orange, where the debtor borrowed in excess of $400 million during its chapter 9 proceeding and used the proceeds to make distributions to certain prepetition creditors, and in particular, certain school districts.
fund of $30 million and an annual cost of as much as $50 million in revenues on a go-forward basis; 7
— The loss of wagering tax revenues in the amount of approximately $11 million per month if the Forbearance Agreement, and the assumption thereof, is not approved by this Court; and
— Needs in connection with any agreement to continue making OPEB payments beyond the current agreement which expires in February, 2014, at a cost of $12 to $15 million per month.
39. Thus, the reality is that the City’s current cash is critically
necessary to simply fund the City’s operations and cannot be responsibly diverted
to fund any meaningful investment in the City, even in the short-term, particularly
in light of these potential down-side risks.
40. Moreover, as will also be established at the hearing on the
Motion, of the $350 million of cited federal funds that supposedly may be used for
City revitalization, only approximately $50 million of such funds cited by the
objecting parties is not already budgeted and would act as a substitute for the
City’s already contemplated reinvestment spending. In any event, the City’s needs
with respect to reinvestment far outstrip available funds.
41. Finally, assertions that the City has “no immediate plans” for
spending the proceeds of the Quality of Life Financing is also of no persuasion.
7 The City vigorously denies that it has any obligation in this regard.
Nevertheless, one of the objecting parties seeking to have the City segregate tax revenues is also arguing that the Quality of Life Financing is unnecessary because the City has sufficient cash on hand to fund any reinvestment initiatives. The two positions cannot be squared.
While the City continues to examine the most effective use of the funds, it is
without dispute that there is no shortage of immediate and urgent needs within the
City, the most pressing of which were set forth in the Motion. If that were not
enough, the Proposal for Creditors presented on June 14, 2013 set forth, in
extensive detail, the initiatives the City intends to embark upon in the coming
years, many of which can be commenced in the very near-term.8 Additionally, on
November 11 and 12, 2013, the City and its representatives held two days of
meetings with representatives of many of the objecting parties, during which it
outlined the City’s planned operational restructuring initiatives, and where nearly
130 pages of information was shared by the City on the very topics covered in the
Motion, among many others. The City has also conducted various due diligence
sessions with advisors of certain creditors and have supplemented both the
Proposal for Creditors and the post-petition financing cash flows with supporting
detail to give greater clarity in respect of the reinvestment initiatives.
42. To suggest that the City “has no plan” for the use of Quality of
Life funds therefore is disingenuous. 9 The City’s operational restructuring
8 See City of Detroit Proposal for Creditors dated June 14, 2013 at pp.
9-22; 61-78. 9 Certain objecting parties have also argued that the proposed pledge of
the wagering tax revenues is not in compliance with applicable Michigan law that authorizes the levy of wagering taxes in the first instance. Section 12(3)(a) of the Michigan Gaming Control and Revenue Act, M.C.L.A 432.312, provides that the
roadmap is well laid out, has been extensively shared with creditors and parties in
interest and is ready, in the near-term, for the City to pursue, at least in part, once
the necessary funds become available.
b. The Financing Satisfies Any Appropriate “Best Interests” Analysis
43. The objecting parties have almost uniformly argued, in one
form or another, that the key element in analyzing the Postpetition Financing is
whether the financing is in the best interest of creditors. The collective argument
in this regard is that the City is not authorized to borrow under section 364(c) of
the Bankruptcy Code unless the proceeds of the borrowing are used to fund only
“essential” services that cannot otherwise be funded through tax receipts and the
use of funds maximizes returns to creditors in some quantifiable manner.
44. In the absence of any binding authority as support for their
novel interpretation of the law, the objecting parties argue that the confirmation
standards under section 943 of the Bankruptcy Code should be the benchmark,
and, in particular, the requirement that a plan of adjustment be “in the best interests
of creditors.” See 11 U.S.C. §943(b)(7).
City may use its percentage of wagering tax revenues for any number of enumerated purposes, including programs “designed to contribute to the improvement of the quality of life in the city.” That is precisely the stated use of the Quality of Life Financing proceeds and, thus, that aspect of the Postpetition Financing complies with Michigan law.
therefore have no bearing on a motion under section 364(c) of the Bankruptcy
Code.
53. Moreover, in Fano the court reversed a lower court order
confirming the debtor’s plan after holding that the debtor was grossly solvent, had
spent extravagantly prior to its bankruptcy filing to improve its infrastructure and,
thus, had sufficient wherewithal to increase taxes to cover its debt service. 114
F.2d at 565-66. As a consequence, the court held that the proposed impairment of
bondholders under the debtor’s plan was not appropriate. id. Thus, Fano stands
for the uncontroversial proposition that a debtor in chapter 9 may need to access its
taxing power in connection with a plan of adjustment to the extent that is possible
under applicable law and the circumstances of the case.10
54. More importantly, however, in no event can Fano be read to say
— whether under section 364 or 943 of the Bankruptcy Code — that a city in
chapter 9 is prohibited from making improvements to its infrastructure and the
services it provides to citizens unless there is a quantifiable enhancement to the
10
On the same day that Fano was decided, the Ninth Circuit issued three other chapter IX decisions: Newhouse v. Corcoran Irr. Dist., 114 F.2d 690 (9th Cir. 1940), W. Coast Life Ins. Co. v. Merced Irr. Dist., 114 F.2d 654 (9th Cir. 1940) and Moody v. James Irr. Dist., 114 F.2d 685 (9th Cir. 1940). All of these decisions were authored by Circuit Judge Stephens. In each of Newhouse, West Coast and Moody, the Court determined that the Districts could not increase taxes to pay creditors and affirmed the confirmation of their plans of adjustment.
recoveries of creditors.11 See, e.g., In re City of Columbia Falls, Mont., Special
Imp. Dists., 143 B.R. 750, 759 (Bankr. D. Mont. 1992) (stating that “[h]ad the
Montana legislature sought to require municipalities to pay all of their debts in full,
regardless of the cost to city services, it could have merely refused to permit
municipalities to file Chapter 9 petitions ….”); Matter of Sanitary & Imp. Dist. No.
7, 98 B.R. 970, 974 (Bankr. D. Neb. 1989) (“[T]he debtor may obtain confirmation
of a plan, over objection, which does not utilize all of the assets of the estate to
retire its obligations.”); Moody v. James Irr. Dist., 114 F.2d 685, 689 (9th Cir.
1940) (“To afford the plan of payment proposed the District must be in a position
to proceed as a going District and for this reason its cash in hand cannot be too
greatly depleted.”). Indeed, “[b]ecause the purpose of municipalities (i.e. police
protection, fire protection, sewage, garbage removal, schools, hospitals) is to
11
Certain of the other “confirmation” cases cited by the objecting parties also do not advance the argument that the Postpetition Financing somehow violates the “best interests” test. Instead, in those cases, the courts found that the “best interest” test was met and reinforces the proposition that the continued ability of a municipality to provide services to its residents in a chapter 9 case is of paramount concern. See In re Connector 2000 Ass’n, Inc., 447 B.R. 752 (Bankr. D.S.C. 2011) (confirming plan and providing that best interests of creditors was served by debtor’s plan); In re Barnwell Cnty. Hosp., 471 B.R. 849 (Bankr. D.S.C. 2012) (confirming plan and noting that “of particular importance to the Court” was the fact that the proposed plan “preserves the availability of healthcare services to citizens and patients in the County.”). In re Pierce Cnty. Hous. Auth., 414 B.R. 702 (Bankr. W.D. Wash. 2009), the other case cited by the objecting parties, is also of no moment here, as that case involved the issue of whether a debtor should abandon certain assets as part of a plan.
/s/ David G. Heiman David G. Heiman (OH 0038271) JONES DAY North Point 901 Lakeside Avenue Cleveland, Ohio 44114 Telephone: (216) 586-3939 Facsimile: (216) 579-0212 [email protected][email protected] Brad B. Erens JONES DAY 77 W. Wacker Dr. Chicago, IL 60601 Telephone: (312) 269-3939 Facsimile: (312) 782-8585 [email protected]
Bruce Bennett (CA 105430) JONES DAY 555 South Flower Street Fiftieth Floor Los Angeles, California 90071 Telephone: (213) 243-2382 Facsimile: (213) 243-2539 [email protected]
Jonathan S. Green (MI P33140) Stephen S. LaPlante (MI P48063) MILLER, CANFIELD, PADDOCK AND STONE, P.L.C. 150 West Jefferson Suite 2500 Detroit, Michigan 48226 Telephone: (313) 963-6420 Facsimile: (313) 496-7500 [email protected][email protected]
I, David G. Heiman, hereby certify that the foregoing Omnibus Reply of the Debtor to Objections to Debtor’s Motion for Approval of Postpetition Financing was filed and served via the Court’s electronic case filing and noticing system on this 10th day of December, 2013.